Hot Off the Web- October 21, 2009

Personal Finance and Investments

This week’s Barron’s has a series of ETF articles in an ETF Special Report, a “primer for newcomers and state-of-the-industry report for pros.” In “Growing to the sky” Michael Santoli reports that there is now $695B invested in 768 funds; the past decade’s 40% per year growth rate in assets can be expected to slow to 20-25% annually over the next 3-5 years. “The core promise of the ETF structure is as it has always been: low cost, tax efficiency, transparency and liquid market exposure. They are access vehicles. For pension funds, mutual funds and financial advisors, ETFs are very effective at providing access to parts of the markets” otherwise inaccessible to retail investors. ETFs are great way to participate in an asset class while waiting to deploy funds in a more specific way. Many believe that the “what’s next” in ETFs are bundled products (ETFs of ETFs), “active allocation programs that use passive products”. Barclays, “goal is to allow an active manager to do all the same things, while shifting his or her product onto a platform that allows “portability” — meaning an investor could move money among funds without triggering taxable events — and providing mechanism for each investor to “pay his own way in and out.” That is, some structure in which one investor’s contribution or withdrawal doesn’t create expense for the rest of the investors in the fund.” (That sounds promising.)  In “Putting bonds in your portfolio mix” Tom Sullivan reports that “ETFs provide an investor with a way to enter fixed-income categories, like high-yield or emerging-markets debt, that “only pros could access” before. “ Examples given include: Vanguard Short Term Bond ETF (BSV), iShares Barclays Aggregate Bond (AGG), SPDR Barclays Capital High Yield Bond (JNK) and SPDR Barclays International Treasury Bond (BWX). In “What you need to know about sector investing” Bob O’Brien reports that “Many of the advisors we deal with have concluded they can generate more stable alpha using a sector approach instead of choosing the right stocks in a sector”. Sector based investing can be defensive or aggressive e.g. “the way to generate the best performance is to over-weight the best- performing and under-weight the worst-performing” sectors. Rotation is what gives the investor the ability to generate alpha, Main’s Arthur says. “It’s a little bit art, and a little bit science.” There are other ETF articles discussing small cap stocks, “Small stocks, big gains” and on “Insuring against economic calamity”  (e.g. discussing SPDR Gold Shares (GLD)).

Jason Zweig in WSJ’s “Take off the blinders when it comes to fees” suggests that you “Look up the annual expense ratio of your mutual fund and multiply it by the total amount of your investment. The result: an estimate of your annual cost, in dollars, of owning the fund. That is roughly what will be deducted automatically from your account over the course of the year. Ask yourself how you would feel if, instead, you had to write one check for that total amount and send it off to the fund company. Would it be good value for the performance you have gotten?” He also suggests that you create a “shadow portfolio” which is “a hypothetical basket of low-cost index funds in the same proportions as the funds you actually own” and after a year compare cost and performance with your mutual fund based portfolio. One of the comments on the article also suggests that you look at “fees as a percentage of earnings” on the portfolio.

Andrew Garthwaite in Financial Times’ “Stay with gold”suggests that gold will hit $1,200 over next year and people should stick with it. Some of the arguments: low Fed funds rate, “gold is still an “under-owned asset” with just 0.7 per cent of global assets under management held as gold or gold equities while the inflation adjusted gold price is still 40 per cent below its previous peak” and “If the Bank of Japan and Bank of China wanted to hold 10 per cent of their reserves in gold (compared with 70 per cent in Europe and 80 per cent in the US), they would have to buy around $250bn worth of gold, more than double the world’s annual gold production”. (I have rebalanced my holdings, reducing gold from about 5.5% to under 4%, which was my strategic asset allocation for gold-apocalypse insurance).

WSJ’s Karen Blumenthal in “Surprise! That 401(k) account is looking good” reports that “Despite the biggest and broadest decline in financial markets in a generation, the median 401(k) retirement account at Vanguard Group on Sept. 30, 2009, was up 7% from where it was two years earlier, when the market was near its all-time high. Seems impossible, doesn’t it?” “How much it rebounded depends on whether you continued to invest regularly and how diversified your portfolio is. Younger investors have bounced back quicker than older ones because their contributions are a larger percentage of their accounts.” (The lessons are clear: diversified portfolios and systematic investing (dollar cost averaging) minimized the pain.)

In Globe and Mail’s “Financial planning: Whom should you trust?” Rob Carrick reports on The Darquin’s who were advised by financial advisor to cash out a (safe) UBC defined benefit pension and invest instead in a leveraged portfolio with disastrous results. (What a rip-off, all in the name of earning some mutual fund commissions on the backs retirees. Shame on the ‘advisor’; this is not incompetence, but likely fraud. Are Canada’s laws/courts up to dealing with this? Time will tell.) Before retiring in 2005, the Darquins had $50,000 debt; they then took $465K cash payout on their pension. Today they have $150K debt and a retirement portfolio of $267K; nice work for their advisor.

Sales of variable annuities with guarantees dropped from about $40B/quarter to about $30B/quarter (still amazing) as insurance companies have reduced the levels of the guarantees and further increased their  cost, reports WSJ’s Leslie Scism in “Insurers retool annuity offerings”. These are products of GMWB flavour, which didn’t make sense before the recent changes, and now they make even less sense.

Real Estate

We should get an update next week on both Canada and U.S. real estate next when the Teranet-National Bank House Index and Case-Shiller reports are published.


“Two articles on the pension crisis are a study in contrasts.  Jacquie McNish’s must read article entitled “Retirement dreams under siege” in the Globe and Mail is a well researched piece of journalism based on facts and respected expert opinion, whereas David Olive’s (don’t bother to read article) “Pension crisis? Not so fast” in The Toronto Star is uninformed schlock riddled with factual errors. The Globe editorial “Beyond the illusion of security” ,accompanying Jacquie McNish’s article, concludes with “As a society, Canada decided many years ago that its older people and retirees should not have to depend purely on family, charity or their own devices to live. But the promise inherent in our patchwork pension framework has unravelled. National will must be summoned to repair it.” The Globe also has an excellent interactive piece at The history of a pension crisis

In Globe and Mail’s “Hybrid pension plans a hard sell” Janet McFarland discusses the strong move from DB to DC plans and then presents what one might call a in-between plan, a “target” benefit plan which has the flexibility to reduce the benefits rather than force employers to make up significant market losses; thus reducing the risk for companies. This could be coupled with more conservative management of the plan assets (perhaps even along the historically advocated asset liability matching approach of primarily using bonds which match liabilities.)

The answer to last week’s report in the Globe based on a Mercer “pilot” study (the same Mercer who are Nortel’s actuaries) that Canada’s “Pension system gets solid ranking”. Well “not so fast” as some would say. Upon perusing the “Melbourne Mercer Pension Index” , there are quite a few caveats stated in it, in addition to the apologetic “pilot” adjective used for the report. On the approach used in the Mercer report: “reliable data in respect to some key indicators remains a significant issue….(but) this should not prevent the comparing of retirement income systems” (damn the data, we know the answer), and “focusing exclusively on benefits provided to a medium income earner does not represent a full spectrum of different income levels….however a more comprehensive approach would add considerable complexity” (we are doing something simple because it’s too much work to do it right), and other similar excuses. If you want a thorough look over a broad spectrum of income levels you must read the much shorter Watson Wyatt study “Shaping private pensions: Analyzing the link between social security and retirement adequacy” which is not based on general qualitative questions from individuals in different countries with different interpretation on the semantics of the questions, but is based on same experts looking at the state of pension system in different countries and analyzing not just the median but the entire spectrum of earnings. For example, looking at Watson Wyatt’s State Benefits Replacement Rate by Income Levels chart, Canada‘s replacement rates for very low to average earners is consistent with other OECD countries looked at; for low end a 0.57-0.65 replacement rate range, while for the average income level a range of 0.45-0.5. However, above 1.4x average earnings Canada has the lowest replacement rates of all OECD countries (except for Netherlands which unlike Canada, has a supplementary “mandatory occupational pension system…positioning it among the most generous OECD countries….in the vicinity of 80%” replacement rate). So yes, in the earnings range that Canada differs from other OECD countries, Canada gets solidly ranked at the bottom of the list. (By the way, unconvincingly, Mercer has also categorized Canada on par with Netherlands, Australia and Sweden, when in fact pension experts have been advocating for years in Canada an approach similar to those countries, as a way to remedy Canada’s flawed pension system. I also didn’t notice (perhaps I missed it) any mention in either report about the fact that Canada’s private sector pension system has minimal/no protection in case the sponsor of an underfunded pension plan seek bankruptcy protection, unlike other jurisdiction which offer pension guarantees up to $50-55K/year; Canada also does not give any priority to pensioners in bankruptcy court. In the areas where Canada’s private sector pension benefits substantively differ from other OECD countries, Canada is firmly at the bottom.

Still, believe it or not, there are some people who believe that Canada’s private sector pension system is one of the finest in the world. They must have been looking at Federal MP’s pensions; for another data point (and a chuckle) see 95 second clip from this week’s Rick Mercer Report then click on Pierre Poilievre.

Things to Ponder

David Graham in WSJ’s “Fixing troubled mortgages for the elderly” report on one of twenty foreclose cases that Bank of America handled innovatively using reverse mortgages. (It doesn’t sound like this will provide much relief to the other millions owners in foreclosure.) “Mr. Garcia owed about $490,000 on his home, which a recent appraisal said is now worth only about $150,000. Bank of America wrote down about $405,000 of the loan. To account for the rest, the bank then issued a reverse mortgage for about $85,000. But instead of paying that amount to Mr. Garcia, as is usual with a reverse mortgage, the bank paid the proceeds to itself…. When he dies, the house reverts to Bank of America, and his heirs can choose to buy it back for the $85,000 plus interest and fees. Or, if the heirs choose to walk away, the bank can sell the house, and any proceeds above the loan amount would go to Mr. Garcia’s family.” (Now this is a reverse mortgagethat would be difficult to refuse.)

In Globe and Mail’s “Why death bonds are an issue of grave concern” David Parkinson discusses serious concerns with ‘death bonds’ (you may have read about “Life settlements” at this website). “The bonds are created by intermediaries that buy up life-insurance policies from policy holders – typically seniors looking to cash out their policies – bundling them together, and selling off small slices to investors. “ The concerns include: cash-strapped seniors selling off their life insurance policies, possibility of securitizing bunched of these policies (like sub-prime mortgages), the ethics of making money off somebody’s early death, questionable sales tactics to convince seniors to sell existing policies and even initiate policies for the purpose of selling the policy, insurance companies which count on certain levels of policy lapses would suddenly face potentially zero lapses.

In Barron’s “Rules made to be broken”Thomas Donlan discusses a big problem with government trying to regulate business called “regulatory capture”. He quotes Richard Posner who argues that “”Regulation is not about the public interest at all, but is a process, by which interest groups seek to promote their private interest….Over time, regulatory agencies come to be dominated by the industries regulated.” (Does this sound like what happened to Ontario’s pension regulators?)

And finally, in Arends and Kansas’s WSJ article “Eighty years after the great crash—‘Is it the ‘30s again?’” there is an interesting graph plotting Nasdaq since March 2000 on top of DJIA for 10 year following August 1929.


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